Fiscal Policy

Case: Yared, P., “The Obama Stimulus“, Columbia CaseWorks, January 3rd 2014 

Case preparation: The Obama Stimulus, November 2021

Note: I usually skip this case and provide a case study instead. 


Lecture handout: Fiscal policy*

Textbook Reading: Chapter 7 (Section 7.1; pp. 200-211) and Chapter 9 (Intro, Section 9.1, 9.2, 9.3, 9.4 and 9.5; pp. 287-325)

Group activity:Fiscal Multiplier Worksheet“, March 2018

UK Public Finances, December 2012

Keynesian approaches to aggregate demand management became popular because they were seen to have explained the problem of the Great Depression. My video on the Great Depression explores some of the history, and see here for more resources on the global financial crisis. The big debate between Keynesian and Hayekian economics was popularised by Russ Roberts and John Papola in the rap battles Fear the Boom and Bust and Fight of the Century. Enjoy!

 

The chart that I used to show estimates of the fiscal multiplier is out of date now, but I keep it in because it is relevant to the Obama stimulus case. For a good overview of more current literature see:

For some documentaries on the Obama stimulus, see:

Narrated by Matt Damon, the 2010 Documentary ‘Inside Job’ (see here for a trailer) stated that “In September 2008 the bankruptcy of the US investment bank Lehman Brothers and the collapse of the world’s largest insurance company, AIG, triggered a global financial crisis.” But the graphic used to accompany the subsequent stock market crash has “bailout defeated” as first main bullet point! As my lecture argues, it may well be the policy uncertainty that accompanied the attempt to intervene in the markets that prompted the disarray and confusion, and not the bankruptcies themselves.

I know that I wouldn’t make a good Jason Bourne, so maybe Matt Damon should leave teaching economics to me…

A practical example of the empirical claims of the signal extraction problem are mentioned in this letter sent to Sequoia founders and CEOs: “In downturns, revenue and cash levels always fall faster than expenses”.

Here’s an example of the state of California’s High Speed rail being more proud of job creation than railway construction (the replies are pretty funny):

Here’s the official website of the Williamson Tunnels and for more on Chinese “ghost towns” you can watch China’s Empty City, read this short World Bank blog post on the Rise of the Chinese Ghost Town, and see footage of controlled demolitions of superfluous and wasteful construction. The photo of manual labourers in North Korea scrubbing the road comes from this article, and my grad school buddy Curtis Melvin created North Korea Economy Watch.

Despite what I say in the lecture… not all dog rescues are disasters…. (see here and here).

The content on policymakers feeling pressurized to “do something” is an element of crisis management more generally. Mirowski (2013) argued that during the global financial crisis “being seen to act… had preempted the equally necessary stage of reflection and reform” (p.5) and I would argue that this is a common feature of crisis management beyond just discretionary fiscal policy.  An interesting example of the types of trade off that policymakers face is BBC Radio 4’s ‘Discussion Time: Coronavirus‘. Even though it relates to an epidemiology situation, it is relevant for any PR situation. Policymakers face a balance between maintaining public confidence, being seen to be providing a quick and clear response, without inciting a general panic. This relies on having good frameworks and tools that relate to the specific situation (the Radio 4 panel explain how important expert forecasts of the spread of foot and mouth disease were, in a recession economic impact studies play a critical role); but also an ability to manage public expectations. The goal of successful crisis management is to balance these things without introducing new uncertainties.

In the lecture I briefly mention the relevance of a specific Reinhart-Rogoff paper for the austerity debate. Fore more on that see here:

Recommended listening:

Some podcast episodes that I particularly recommend:

Learning Objectives: Assess the efficacy of fiscal stimulus and aggregate demand management. Perform back of the envelope calculations to estimate the fiscal multiplier for a range of different countries.

Focus on diversity: Christina Romer was the Chair of Obama’s Council of Economic Advisors during the stimulus. You can learn more about her here

Public Finance

Case: “Rovna Dan: The Flat Tax in Slovakia”, Harvard Business School case no. 9-707-043, March 2010


Textbook Reading: Chapter 7 (Intro, Section 7.1 and 7.2; pp. 199-216)

In 2011 the Mirrlees Review published ‘Tax by Design‘, a comprehensive overview of UK tax reform.

In terms of a flat tax, here is a short video asking  Would a Flat Tax Be More Fair?” There’s a good HBS article, from 2007, called “All Eyes on Slovakia’s Flat Tax”. Slovakia repealed the flat tax in January 2013, by adding an additional rate of 25% for incomes over €38k. You can read about on this LSE Blog: Slovakia has abolished its flat tax rate, but other Eastern and Central European countries are likely to continue with the policy.

Here are some newspaper attempts to explain fiscal implications of tax policy:

Regarding public finance more generally, in 2012 I participated in the 2020 Tax Commission. You can read our report here.

Regarding tax compliance, you may hear things like:

Apple can pretty much choose how much tax it wants to pay and to whom. One EU estimate was that it paid less than 0.01% tax on profits of over $100 billion (Frisby 2019, p.175)

This may be true, but I do not think that this means that tax is voluntary. The choice that Apple have is over what activities they undertake, each of which have different tax implications. So they can affect their tax obligations, but only in as much as they alter their business decisions.

In his 2023 book, ‘The Crisis of Democratic Capitalism’, Martin Wolf identifies the following two problems with the existing tax code:

  • That interest on debt is tax deductible – this incentives firms to favour debt over equity
  • That “carried interest” is exempt from income tax, even though it operates more like income than a capital gain (since the downside is capped at zero). This is a favoured means of compensation for general partners in private equity or hedge funds.
  • For more Wolf, M., 2023, The crisis of democratic capitalism, Allen Lane, p. 167-168, p. 290
Group activity: Personal Taxation, December 2020

Learning Objectives: Understand alternative types of tax regime.

Focus on diversity: Harriet Martineau (1802-1876) is best known as a pioneer of sociology, but contributed to the populising of classical economic insights on taxation.

Growth

Lecture handout: Growth*

⭐ Required readings:

Watch: Growth is like an iPhone


Here is an example of Prague’s enduring beauty. But rather than look at this image and think about preservation of the status quo, I look at it and think of the amazing growth that transformed it from a hamlet to the city shown in 1910. Indeed, any historic and enduring beauty is testimony to previous growth and ambition.

In some places, such as Lodz, aesthetic streets are about returning to past beauty. This just shows that the destruction of growth is a terrible thing, and we should appreciate its manifestation where we have it.


This video by Ollie Bye shows the evolution of the largest cities in the world (by population).

You can test your knowledge of it with this short quiz.

Activity: Largest cities
Activity: Growth activity
Activity: Free Markets in Chile
Activity: Economic Freedom Parlour Game

You can read my essay that summarises the key points from this session here:

Here is my video using the iPhone analogy:

I go deeper with this framework with my Country Competitiveness Dashboard.

Recommended podcasts

Recommended article

Recommended books

  • Koyoma, M., and Rubin, J., 2022, How the world became rich: The historical origins of economic growth, Wiley – Mark and Jared survey the main explanations for economic growth, including geography, institutions, culture and exploitation, with a focus on why the Industrial Revolution occurred in England and how it then spread to other countries across the world.
  • De Long, B., 2022, Slouching towards utopia, Basic books – this is a large tome and covers a lot of ground, but is empirical, readable, and an important work.

 Recommended videos:

Plunder

The lecture talks about how countries get rich. One strategy that isn’t mentioned is plunder. The main reason for this is that colonial exploitation and other forms of resource extraction can undoubtedly harm some groups, and benefit others, but overall there is no obvious reason why this would create wealth. Theft is at best a zero-sum transfer, whereas particularly since 1870 we’ve seen vast swathes of the global population getting richer.

For more on this see:

Or listen to this podcast:

The Solow model

The foundational growth model is the Solow Model. Marginal Revolution have a series of excellent videos, starting here:

But I’m a Solow skeptic!

Learning Objectives: Understand the foundations of economic growth. See how economic growth theories inform development economics. 

Cutting edge theory: This session defines cutting edge growth 

Focus on diversity: One of the most widely respected economic historians of the factors that led to industrialisation is Deidre McCloskey

Spotlight on sustainability: This session defines the sustainable growth rate as the balanced path between capital accumulation and capital consumption.

Market-Based Management (R)

Reading: Finegan, J., “Pipe Dreams” Inc.com Magazine, August 1994
Instructor’s resource: MBM Dimensions
Further activity:

Additional resources:

Learning Objectives: Understand and apply Market-Based Management

Corporate Entrepreneurship

Case: Weston, Hilary A., 2000, “Automation Consulting Services”, Harvard Business School Case No. 9-190-053

The following discussion questions can be used:

Instructor’s resource:

Learning Objectives: Understand organisational control mechanisms.

Focus on diversity: Hilary A. Weston was one of the co-authors of the ACS case. 

Prediction Markets

Case: Coles, Peter, Lakhani, Karim and McAfee, Andrew, “Prediction Markets at Google” Harvard Business School Case No. 9-607-088, August 20, 2007

Case preparation: Prediction Markets”, February 2016

Textbook Reading: Chapter 4 (Section 4.5; pp. 127-134)

I am Facebook friends with someone who used to work at Google – here’s a photo of one of the T-shirts:

The Google case was published in 2007 and was accompanied by a lot of interest in prediction markets. In 2021 they launched a new internal prediction market because of two main reasons:

  1. Even more Google employees (i.e. a bigger crowd)
  2. Better technology in the form of Google cloud

I am an academic not an entrepreneur, but if there’s one area that I think is ripe for a successful venture it’s creating the go to prediction market. By the early 2000s we had established that prediction markets were an effective tool for corporate management, and we also learnt how useful they could be for a broad range of policy issues. It’s a scandal that governments – and the US in particular – have been so opposed to their use. (The reason is that they’re treated either as gambling firms or futures traders which are two of the most targeted and heavily regulated and industries). According to Scott Alexander:

There ought to be a billion dollar prediction market, maybe a ten billion dollar one. Smart VCs clearly believe something like this, or Kalshi wouldn’t have gotten $30 million+ in investment. Sometimes people who incorrectly believe I know things about prediction markets ask me if know the missing secret sauce. I don’t think there’s any secret. A prediction market will strike it big when it gets three things right at the same time:

    • Real money
    • Easy to use
    • Easy to create your own subsidized markets

It’s a dream of mine that I may have students who manage to put those things together, solve the regulatory issues, and launch a killer app. So far the closest is probably Polymarket but also see Prediki. Here is a website that aggregates prediction market data:

That said, Michael Story is a superforecaster and has made some important criticisms of prediction markets. See here.

Here are a couple of op-eds on the benefits of insider trading:

Here is a New York Post article explaining how Nancy Pelosi (and her husband) have benefitted from trading off the stocks of companies that she regulates, and why she is resisting efforts to stop Congressional lawmakers from being able to continue to do so. You can track her trades here. Here is a funny halloween costume.

To read more about the “Policy Analysis Market” (PAM) which was designed by Robin Hanson as a tool for the US Department of Defense, but got cancelled in July 29th 2003 having been described as a “terrorism futures market” by the Washington Post, see:

The Climate Risk and Uncertainty Collective Intelligence Aggregation Laboratory (CRUCIAL) uses prediction markets to learn more about future climate related challenges. See:

Or this video:

 

Finally, for more about the management failure that led to the Challenger disaster, see:

Recommended reading
Recommended video

Recommended audio

Why There Aren’t So Many Hotel Fires Anymore” Stuff You Should Know.

Points to consider:

    • Key technology = fire doors, sprinklers, and alarms that anyone can set off. Imagine how many major hotel fires would occur if staff had to wait to inform senior management before receiving authorisation to call the fire brigade.
Learning Objectives: Understand how to operate a prediction market.

Internal markets

Case: Wessen, R.R. and Porter, D., “The Cassini Resource Exchange” Ask Magazine 16, Fall 2007, p. 14-18

Textbook Reading: Chapter 4 (Section 4.5; pp. 127-134)

For more on the Cassini mission, see here: https://science.nasa.gov/mission/cassini/

Watch Cassini’s grand finale:

I find it a real shame that for many years I’ve been opening students eyes to the economic benefits of utilising internal pricing between different business units, but almost all attention to “transfer pricing” in the last 10 years or so is in terms of tax avoidance (and therefore something to be discouraged). In terms of useful cases, the most relevant ones from HBR are all pretty old, although Knowledge at Wharton have an interview that covers IBM’s utilisation of transfer pricing.

In terms of metrics, I like this warning from Jeff Bezos:

Somebody a long time ago invented that metric… [and] they had a reason why they chose that… but that metric is the proxy… And then fast forward 5 years… and a kind of inertia can set in, and your forget the truth behind why you were watching that metric in the first place, and the world shifts a little, and now that proxy isn’t as valuable as it used to be, or it’s missing something, and you have to be on alert for that and know ‘I don’t really care about this metric.. and this metric is only worth putting energy into, and following and improving and scrutinizing only in so much as it actually affects [what I care about]’. [You have to be on guard against] managing metrics that you don’t really understand, you don’t know why they exist, and the world may have shifted out from under them a little and the metrics are no longer as relevant as they were.

Learning Objectives: Think creatively about how to use markets within organisations

Signalling

Reading: Spence, M., 1973, “Job Market Signaling”. Quarterly Journal of Economics 87(3):355–374
Lecture handout: Signalling*

Textbook Reading: Chapter 3 (Section 3.4; pp. 90-96)

Here’s a lecture video providing an example of the model.

Here’s my treatment of signalling and countersignalling:

In “What toffs and plebs share“, Ed West uses the signalling vs. counter signalling distinction to argue that institutions such as horse racing or the army demonstrate a unity of peasant culture and aristocracy. He identifies a U-curve of social patterns, with those in the middle trying hard to distinguish themselves from those below, even though this reduces their ability to mix with those at the top.

Recommended audio:

Recommended video:

This debate considers the extent to which higher education is merely signalling:

Learning Objectives: Understand the returns to education

Focus on diversity: Claudia Goldin is a world leading labour economist, a former president of the American Economic Association, and co-author of a highly influential book on the earnings gap between high skilled and low skilled workers. She is also a pioneer for studying the role of women in the economy and won the Nobel Prize in 2023. See here for a video profile.

 

Adverse Selection

Reading: Akerlof, G.A., 1970, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism“. Quarterly Journal of Economics 84(3):488–500 (£)

Textbook Reading: Chapter 3 (Section 3.4; pp. 90-96)

Group activity:

  • If you are a bit daunted by an academic article, George Akerlof wrote a very interesting essay on how he came up with the ideas and the process of working on the topic. You can read it at the Nobel site.
  • Further reading: Secrets and agents“, The Economist, July 23rd 2016

Here’s a good video explaining the lemons problem:

Learning Objectives: Think critically about the role of asymmetric information on market performance

Cutting edge theory: Product heterogeneity and customisation

Focus on diversity: Amy Finkelstein, of MIT, was featured by The Economists 2008 list of emerging economists for her work on asymmetric information in health insurance. She won the John Bates Clark medal in 2012.

Spotlight on sustainability: Importance of long term reputational effects of short term strategic choices

Capital Theory

Lecture handout: Capital theory*

Textbook Reading: Chapter 6 (pp.165-197)

There is still a website containing the “Millennium Dome Collection”, but this Guardian article provides a thorough retrospective. Here is a lovely list of repurposed American gas stations.

Here is the video of the Sinclair C5 Infomercial:

For more on business plan ecology, see

For a book length treatment of the concept of intangible capital see:

The lesson for economic policy in a world of intangibles is to invest in “knowledge infrastructure”, i.e.

  • Education
  • ICT
  • Urban planning
  • Public science

For a nice attempt to avoid treating intangibles as a residual, or less clear category and a meaningful attempt to conceptualise and study them see:

  • Crouzet, Nicolas, Janice C. Eberly, Andrea L. Eisfeldt, and Dimitris Papanikolaou. 2022. The Economics of Intangible Capital.” Journal of Economic Perspectives36 (3): 29-52.

They argue that intangibles require a storage medium, where “The medium can be a piece of physical capital, like a computer (for software), or a document (for a patent or a design), or a person (for a method or an innovation).” This need for a storage medium implies two things:

  1. Non-rivalry in use
  2. Limited excludability

They argue that, “the extent to which these properties generate a valuable intangible asset— which motivates investment—depends on the properties of the storage technology, and the resulting non-rivalry and excludability, and the institutions that enforce property rights.”

The entrepreneurial state

Some people, such as Mariana Mazzacuto, argue that states should be bolder about their role in technological innovation, and that ‘directed planning’ can improve on market outcomes. Here key work is:

  • Mazzucato, M. (2013). The entrepreneurial state. London: Anthem Press.

Mark Pennington has provided a good critique of this view, however. For example:

  • “she ignores the opportunity costs of the spending she claims was partly responsible for innovation and growth”
  • [she] “fails to recognise that those elements of public spending that may have generated benefits were not ‘planned’.” (Indeed they “appear to have been unintended or accidental consequences emerging from essentially random spending in the defence sector”).

In conclusion, “the Mazzucato case for state-based experimentation… is the suggestion that if governments commit to spending enough public money on their favoured projects it would be remarkable if none of this expenditure did any good. Yet, this position hardly amounts to an endorsement of the transformational potential of the state.”

Microclimate

When talking about macroeconomics I think it’s important to distinguish between the overall economy and the circumstances of an individual firm. We can’t always assume that macro conditions are felt the same by each company within it. I explain more in this video:

 

Unemployment and the labour market

This article from the New York Times has a great visualisation of how unemployment is measured.

The most striking fact about labour markets over recent years is the decline in labour force participation across the developed world:

By contrast, labour force participation of women has increased:

Martin Wolf believes this is due to the following main factors:

  • Declining fertility (due to lower infant mortality and, perhaps, seat belt laws)
  • Lower household maintenance costs
  • Declining relevance of physical strength for productive activity
  • Rise of the service economy

But notice how, in the US, the prime-age female participation rate has in fact  fallen from 2000 to 2019. These images are from: Wolf, M., 2023, The crisis of democratic capitalism, Allen Lane, p. 96.

Learning Objectives: To understand what capital goods are

Spotlight on sustainability: Look at instances where resources have been reconfigured for alternate uses